Friday, 30 November 2012

I have analyzed and replicated the IMF’s Debt
Sustainability Framework for Portugal provided in the adjustment program review
reports (a table in the IMF Country Reports for Portugal). This IMF review
report table contains the IMF projections for the levels of Portugal’s public
debt from 2012 through 2030. The IMF review reports are the data sources for
all graphs below.

In my opinion, the IMF’s debt projections should
be interpreted as the “objectives” for the evolution of the levels of public
debt, should the adjustment program perform as planned.

As is well known, the key condition to assure
debt sustainability is that the economic (nominal/real) growth rate is higher
than the (nominal/real) interest rate on the stock of debt.

The key points of my short analysis are:

Even
if the everything goes according to the troika and government plan, public debt
dynamics seems barely sustainable, falling below 100% of GDP only around 2025

Each
review has resulted in the worsening of the public debt trajectory (please see
figure below).

This
is to some extent explained by increases in the initial stock of debt – for example,
resulting from Eurostat-mandated changes in the universe of public sector
enterprises included in the consolidated accounts of the public sector. But one
additional important explanation is that the adjustment program has had a worse
than expected impact on economic growth resulting in lower growth projections
with each review (please see figure below)

Maybe I missed something, but I could not replicate the debt levels for 2014 and 2015. The difference in 2014 and 2015 debt levels explains 94% of the deviation between my 2030 estimates (debt at 88% of GDP) and the IMF's 5th review projection (84.8% of GDP)

The
IMF has, in each successive review revised interest rates lower (see figure
below). (Addendum) Francesco Franco pointed out that at least some of the reductions in interest rates follow from the reduction in EU loan rates to Portugal - the 215 basis point EFSF margin was reduced to 0 - (Bloomberg’s
David Powell recently noted what he called the "mysterious" reduction in interest rates from the
4th to the 5th review report, and this had me look at the
evolution of interest rates in all IMF review reports).

Moreover,
the debt trajectory is not really robust (see figure below). In fact, if nominal growth rates from 2012 turn out to be lower by one percentage point and the
average interest rate from 2015 on to be higher by one percentage point than
assumed by the IMF, the debt levels would rise by 2030, not fall.

The “Fazit”: Portugal’s sovereign debt is on a clearly
unsustainable trajectory. The IMF public debt projections fail to consider the impact on public
debt trajectory of the external adjustment that is necessary to assure a
sustainable external debt trajectory. The IMF external debt projections contained
in the review reports are in my view, not realistic and not feasible at all.
But that is a subject for another discussion.

Saturday, 10 November 2012

One month ago, the IMF presented evidence that structural macro econometrics models used by international organisations are underestimating current fiscal multipliers. Last week the European Commission presented evidence that focusing on the euro area the IMF results need to be interpreted with caution. To EC study acknowledges that there are good reasons why the fiscal multipliers can be larger in the current environment but also says that she finds no evidence of underestimation of those, al least when focusing on the euro area countries.

More precisely the EC study argues that (I quote):

1."the forecast errors over the 2010-11 period have been predominantly underestimations of higher-than-expected growth in 2010, which were in fact associated with stimulus measures in that year";

2. "when controlling for increases in sovereign-bond yields the correlation between forecast errors and changes in the fiscal stance breaks down."

Reason 1. says that the fiscal multipliers may be underestimated, but this is due to countries that have adopted a stimulative fiscal stance (I would add: good for them!). Furthermore these stimuli are temporary in nature and imply higher multipliers than those due to permanent fiscal consolidations.

The empirical exercise is performed using structural fiscal balance, a measure that is constructed to filter out temporary factors from the actual fiscal balance. The reason why negative forecast errors in the structural fiscal stance are associated with temporary fiscal changes while positive forecast errors in the structural fiscal stance are associated with permanent fiscal changes eludes me. If this was true I would look at structural fiscal balance measures suspiciously.

Reason 2 is harder. In the EC study, adding as an explanatory variable the change in government yields, the underestimation result disappears.

The explanation is as follows:

"…the negative coefficient for the fiscal stance in the first regression should not be interpreted as an underestimation of the fiscal multiplier but rather as capturing a negative response of investors to possibly insufficient fiscal effort in countries with severe debt problems."

I would argue that the case for reverse causality is strong: were the yields reflecting the preoccupation of the markets for a not strong enough fiscal consolidation or for a not strong enough economic growth? In the latter case the regression suffers from an endogeneity problem (see IMF footnote 3) and the coefficients estimates would be biased.

Here I report the benchmark results using the IMF and the EC data for the euro area countries. (GFE is cumulated growth forecast errors and FCFE is cumulated fiscal consolidation forecast errors).

Notice how the estimates are close. The main differences in the two datasets appear to be: 1. the presence of Luxembourg in the EC data, and 2. a significant difference (sign and size) in the forecast error of the fiscal consolidation of Ireland.

Monday, 5 November 2012

In May 2010, the troika announced a rescue plan for Greece. Ireland followed in November 2010. In May 2011 it was time for Portugal to be bailed out. In July 2012, Spain received special assistance for its banks - more is expected to come.

One of the main questions concerning these economies is: How similar is their evolution? In other words, if we look at one of them, will we be able to say what happened, or what is happening, or what will happen to the other economies?

Greece has been at the centre of the euro area sovereign debt crisis. Private holders of Greek bonds have already suffered a haircut. Exit from the eurozone is openly discussed. In Portugal, many voices have expressed concern at the possibility that austerity measures will make Portugal tread in Greece's footsteps. Nuno Garoupa, for instance, wrote that Portugal lags Greece by eighteen months.

At the time of writing, the indicators presented below show that Greece stands out for its worse performance among this group of countries, except for private debt - where Ireland reports the largest ratio to GDP - and for the net international investment position - where Portugal performs worse.